1. Field of the Invention
This invention relates to methods for allocating or distributing a given quantity into a number of predetermined categories and more particularly to an such methods involving multiple allocation steps.
2. Description of the Prior Art
Large organizations have accounting and expense management systems. An important function of these systems is the classification of financial transactions and expenses into useful categories. For example, transactions are classified into income, expense, asset, liability, and capital accounts. In many cases, the transactions must be further classified into other categories for the purposes of management accounting.
In typical accounting terminology, the problem of allocating expenses arises when an enterprise has both service and production departments. In a simple model, production departments produce goods for sale and all of the cost of the service departments is attributable to those goods. Service departments provide services to production departments and also to each other.
The costs of operating the service departments are part of the cost of running the enterprise so they must be attributed or allocated to the goods produced so that the final costs will reflect the total costs of the enterprise. When service departments provide service to each other, the process is called reciprocal allocation.
The simplest form of allocation is called the direct method. Reciprocal allocations are ignored and all the costs of the service departments are allocated to production departments according to some basis, normally the proportionate use of the service by the production departments. When the amount of services provided to other service departments is large, this can produce significant distortion.
Another form of allocation is called the step or sequential method. One service department is chosen, usually the one that provides the largest dollar value of service, and its costs are allocated to all of the other departments, service and production. The process is repeated with the next service department. Its costs, possibly augmented as a result of the first step, are allocated to all of the remaining departments, that is to all departments except the one that was treated in the first step. The process is repeated until all the costs of the service departments have been allocated this way. The step method recognizes some, but not all, of the influence of reciprocal allocation.
The term reciprocal allocation is reserved for a third method, although the previous two methods deal with reciprocal allocations to some degree. The reciprocal allocation method is well known and gives full account to reciprocal allocations among service departments. It is based on calculation of an intermediate quantity that has no natural interpretation. For each service department, the intermediate quantity is equal to the preallocated costs of that department plus the proportional share of the preallocated costs of the other service departments that is due to its use of the service of those departments. This relationship can be expressed as an equation. Taken together, the equations for all of the service departments can be treated as a system of simultaneous equations. The solution of the system yields the intermediate quantities for all of the service departments. The difficulty of interpretation comes about because the sum of the intermediate quantities, which are augmented service department costs, exceeds the sum of the actual service department costs.
The second step of the process produces the final amount of service department cost allocated to each production department. This is done by using the allocation fractions of service department costs to production departments. When these allocations are applied to the intermediate augmented costs described in the first step, they yield the final amount of service department costs allocated to each production department. These costs will sum to the total service department costs.
For example, consider an advertising expense. A purchase of advertising would result in a transaction to reduce a cash account and another to increase an advertising expense account. The advertising expense might be classified (reallocated or redistributed) to the expense accounts of some number of marketing channels. It could then be further reallocated to the expense accounts of some number of manufacturing plants and then to the expense accounts associated with some number of products made in each manufacturing plant. Thus, there is a cascading network of many levels of reallocation. Consequently, the expense is reallocated several times in the process of developing the ultimate classification.
It is common practice to do this sort of reallocation at the end of the period in connection with closing accounts. To do this, reallocation proportions are provided to the accounting system.
The prior art processes, even when implemented on high-speed computers, are slow and inefficient. Furthermore, the prior art, due to the cascading nature of the allocation rules, does not provide a statement of where an initial expense will ultimately be allocated.
The prior art contains extensive literature on the use of matrix methods for expense allocations, focusing on the solution of simultaneous equations of the type discussed above. Much of the literature on solving simultaneous equations is also applicable.
The prior art reciprocal allocation method has certain disadvantages. Because the reciprocal allocation method works with summarized costs from-the outset, it requires that those costs must be accumulated before the process can begin. This accumulation cannot be completed before the end of an accounting period. Consequently, important accounting information is not available until the end of the accounting period and management decisions may have to be delayed until that time.